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EC 100 Class 9

EC 100 Class 9. Sixth Class Exercise. This week: Measuring Inequality Lorenz curve : Being on 45 degree line is perfect equality – 1% of population earns 1% of total income. A very flat curve that rises steeply reflects high income inequality. . Question 1. +

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EC 100 Class 9

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  1. EC 100 Class 9

  2. Sixth Class Exercise • This week: Measuring Inequality • Lorenz curve: Being on 45 degree line is perfect equality – 1% of population earns 1% of total income. • A very flat curve that rises steeply reflects high income inequality.

  3. Question 1 • + • Which of them represents the higher level of inequality?

  4. Question 1 • A very flat curve that rises steeply reflects high income inequality. • SoCurve A has higher inequality

  5. Question 2 • If Sweden has a lower Gini coefficient than the UK, does Sweden have higher or lower income inequality than the UK? • Gini coefficient measures inequality • Higher Gini coefficient means higher inequality • Gini = 0 (no inequality) • Gini = 1 (complete inequality)

  6. Question 2 • Gini coefficient = A / (A+B) in graph • With low inequality, area A is very small • So Sweden’s Lorenz curve will be higher than UK (smaller area A)

  7. Question 3 • Suppose the government provides a benefit of £100 per week to people with no other source of income. But, for every extra £1 in income they earn, the government reduces their benefit by 75p. Assume for simplicity, there are no other taxes and benefits. If an individual earns £100 how much benefit will they receive:

  8. Question 3 • Note: Person receives £100 in benefits if does no work • Receives £25 if earns £100 • So overall, person only gains £25 from working • Problem: As you earn more, your benefits start to fall (Why?) • Losing benefits is like an additional tax on working

  9. Question 3 • As you earn more, your benefits start to fall (Why?) • “Iron triangle” • Want to achieve 3 things: • raise the living standards of low-income families • provide incentives to work • keep costs low

  10. Question 4 • If individual in previous question earns £100, what is their average tax rate?

  11. Question 4 • The persons total income when working and earning 100 Pounds is 125 • She is still a net recipient of transfers, so her tax rate is negative

  12. Question 5 • If individual in previous question earns £100, what is their marginal tax rate? • Marginal tax rate: effective tax rate on additional income • “Effective” means we are including lost benefits • Can see that this is 75% without the formula from lectures, but you can also use it if you wish: • (Just re-arrange to get marginal tax rate on its own – see board).

  13. Question 5 • For every pound she is earning through work, she has to give up 75 pence of transfers… • This is a common problem amongst low-income households

  14. What are effects of taxes on labour supply?Why do we care about labour supply?!

  15. Question 6 • If the average tax rate increases with the level of market income how do you think the Gini coefficients of final and market income will compare?

  16. Question 6 • Final income: market income – taxes + benefits • Average tax rate increases with income – this implies that rich pay a higher tax rate than the poor. • Hence after-tax Lorenz curve moves closer to line of equality, and thus Gini coefficient falls

  17. Question 7: When working doesn’t pay off… • Who has highest marginal tax rate? • Why?

  18. Question 8 • Suppose I believe that the impact of marginal and average tax rates on the amount people work is very small. Other things equal, am I likely to favour:

  19. Question 9 • Suppose the economy is doing really badly and there now fewer rich people than before and more poor people. Other things equal, am I likely to favour:

  20. Question 10 • Suppose average level of income in the economy is the same as before but the economy is becoming more unequal and there now both more rich people than before and more poor people. Other things equal, am I likely to favour:

  21. Discussion Question: Inequality and Inter‐Generational Mobility

  22. Inequality over Time • Horizontal axis measures Gini coefficient • Vertical axis is a measure of how much your wealth depends on your parents wealth. • So graph shows: • Countries with high current inequality (Latin American countries) also have low intergenerational mobility (if you come from a poor background, you will also be poor) • Krueger: Suggests that high inequality is associated with low equality of opportunity • Do you agree with this conclusion?  And if this is a problem, what might you think could be done  about it? 

  23. Inequality over Time • Krueger: Suggests that high inequality is associated with low equality of opportunity • Do you agree with this conclusion?   • Is this a problem? • What can be done about it?

  24. Inequality over Time • Krueger: Suggests that high inequality is associated with low equality of opportunity • Do you agree with this conclusion? • Difficult not to agree! • Could argue that rich parents are more talented, so their children will be more talented… • So we might expect some intergenerational persistence of income even with complete equality of opportunity • Could also argue that with very high average taxes, Gini coefficient will be low – lots of redistribution from rich to poor • But does this really imply equality of opportunity?! May still only be powerful families taking best jobs etc.

  25. Inequality over Time • Krueger: Suggests that high inequality is associated with low equality of opportunity • Is it a problem? • See next slides…

  26. Positive: • It may be inefficient. Maybe a lot of talent is not receiving the education or access to education that could activate their talents (hidden Einsteins). • Maybe the reason why relationship is so strong is because poor lack access to credit (microfinance in India) • ….

  27. Normative: arguments along the line of… • Equality of opportunity ought to exist in a fair society • The only way to create equality of opportunity is through access to public services, like schools (this is an empirical question that needs to be proven). • …

  28. Inequality over Time • Krueger: Suggests that high inequality is associated with low equality of opportunity • What can be done about it? • Relatively easy to affect Gini coefficient (difficult part is doing it in a way that doesn’t seriously damage the economy or cause political unrest) • How do you increase intergenerational mobility? • Avoid ghettos – mixed tenancy housing • Lots of schooling options • Sure Star in UK seems to have been effective • Grammar schools? • Ban private schools? • School assignment by lottery? • (Heavily) subsidised further & higher education? • Others…

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